CHAPTER ONE

PROCESS COSTING
Process costing is a costing method used where it is not possible to identify separate units of
production, or jobs, usually because of the continuous nature of the production processes
involved. The physical nature of the processes involved makes it hard to identify and associate
specific units of direct labour and direct materials to the final product e.g. Oil refining, Foods
and drinks, Paper, Chemicals, etc.
Process costing can be represented as follows:

Production moves from one process (or department) to the next until the final completion occurs.
Each production department performs some part of the total operation and transfers its completed
production to the next department, where it becomes the input for further processing. The
completed production of the last department is transferred to the finished goods inventory.
The costs can built-up as follows:-
Process A

K K
Labour 5,000 Transferred to 10,000
Materials 4,000 process B
Overheads 1,000 .
10,000 10,000

Process B

K K
Transferred from Transferred to
process A 10,000 finished goods stock 18,000
Labour 3,000
Material 4,000
Overheads 1,000
18,000 18,000

Finished Goods Stock

 K
Transferred from
process B 18,000

Features of process costing

a) The output of one process becomes the input to the next until the finished product is
made in the final process.
b) The continuous nature of production in many processes means that there will usually be
closing work in progress which must be valued. In process costing it is not possible to
build up cost records of the cost per unit of output or the cost per unit of closing
inventory because production in progress is an indistinguishable homogeneous mass.
c) There is often a loss in process due to spoilage, wastage, evaporation and so on.
d) Output from production may be a single product, but there may also be a by-product (or
by-products) and/or joint products.
Process Losses
Losses may occur in process as they are inherent in production and cannot be eliminated even
under efficient operating conditions e.g. liquid may evaporate, cloth pieces may be cut off in
designing a suit, etc. But sometimes the losses can also occur due to negligence of Labourer,
poor quality raw material, poor technology etc.
If a certain level of loss is expected, this is known as normal loss/ expected loss/
uncontrollable loss. If losses are greater than expected, the extra loss is abnormal loss. If losses
are less than expected, the difference is known as abnormal gain.
Abnormal events do not affect the cost of good production. Their costs are analysed separately in
an abnormal loss or abnormal gain account.
Example
A product passes through three processes to complete in period 3. The cost of production was as
follows:
Total Process 1 Process 2 Process 3
Direct Material (K) 84,820 20,000 30,200 34,620
Direct labour (K) 120,000 30,000 40,000 50,000
Direct expenses (K) 7,260 5,000 2,260
Factory Overhead 60,000 (absorption rate 50% of direct wages)
1000 units at K50 per unit were input process 1
Output of each process 1 920 units
2 870 units
3 800 units
Normal loss was estimated as
Process 1 10%
2 5%
3 10%
Scrap value of losses process 1 K30/ unit
2 K50/ unit
3 K60/ unit
Show process accounts and abnormal gain/loss accounts.
Solution
Process 1
Units Cost/U K Units Cost/U K
Inputs 1000 50 50,000 Normal Loss 100 30 3,000
D materials 20,000 Process 2 920 130 119,600
D labour 30,000
D expenses 5,000
Factory O/h’s(50% labour) 15,000
120,000
Abnormal gain 20 130 2,600
1020 122,600 1,020 122,600

Cost = Normal cost / Normal Output = (120,000-3,000)/(1,000-100) = K130/unit

Process 2
Units Cost/U K Units Cost/U K
Process 1 920 130 119,000 Normal Loss 46 50 2,300
D materials 30,200 Process 2 870 240 208,800
D labour 40,000 Abnormal loss 4 240 960
D expenses 2,260
Factory O/h’s(50% labour) 20,000
212,060
920 212,060 920 212,060
Cost = (212,060-2300)/(920-46) = K240
Process 3
Units Cost/U K Units Cost/U K
Inputs 870 240 205,800 Normal Loss 87 60 5,220
D materials 34,620 Finished Goods 800 400 320,000
D labour 50,000
Factory O/h’s(50% labour) 25,000
318,420
Abnormal gain 17 400 6,800
887 325,220 887 325,220

Cost = Normal cost / Normal Output = (318,4200-5,220)/(870-87) = K400/unit

Scrap Account
Units CPU K Units CPU K
Process 1 100 30 3000 Abnormal gain 20 30 600
Process 2 46 50 230 Abnormal gain 17 60 1020
Process 3 87 60 5220 Cash 7030
Abnormal loss 4 50 200
8650 8650

Abnormal loss Account

Units CPU K Units CPU K
Process 2 4 240 960 Scrap account 4 50 200
Profit & loss a/c 760
4 960 8650

Abnormal gain Account

Units CPU K Units CPU K
Scrap A/c 20 30 600 Process 1 20 130 2600
Scrap A/c 17 60 1020 Process 3 17 400 6800
Profit & loss 7780
A/c
9400 9400

Notes
 The scrap value of normal loss is usually deducted from the cost of materials.
  The scrap value of abnormal loss (or abnormal gain) is usually set off against its cost, in
an abnormal loss (abnormal gain) account.
 If there is a closing balance in the abnormal loss or gain account when the profit for the
period is calculated, this balance is taken to the income statement: an abnormal gain will
be a credit to the income statement and an abnormal loss will be a debit to the income
statement.
Valuation of Work In Progress
When units are partly completed at the end of a period (and hence there is closing work in
progress), it is necessary to calculate the equivalent units of production in order to determine
the cost of a completed unit.
Equivalent units are notional whole units which represent incomplete work, and which are used
to apportion costs between work in process and completed output.
Process Account
Units K units K
Material 1000 6200 Finished goods 800 ?
Labour and overheads 2850 Closing WIP 200 ?
1000 9050 1000 9050

assuming that the degree of completion is as follows.

a) Direct materials. These are added in full at the start of processing, and so any closing
WIP will have 100% of their direct material content. (This is not always the case in
practice. Materials might be added gradually throughout the process, in which case
closing inventory will only be a certain percentage complete as to material content.)
b) Direct labour and production overhead. These are usually assumed to be incurred at an
even rate through the production process, so that when we refer to a unit that is 50%
complete, we mean that it is half complete for labour and overhead, although it might be
100% complete for materials.
Let us also assume that the closing WIP is 100% complete for materials and 25% complete
for labour and overhead.
1st – Calculate equivalent units
Materials Labour and Overheads
Total units Degree of Equivalent Degree of Equivalent
completion Units completion Units
 Finished 800 100% 800 100% 800
output
Closing WIP 200 100% 200 25% 50
1000 1000 850

2nd – Calculate average cost per equivalent unit

cost incurred in the period
Equivalent units of work done

- Materials = K6200/1000units = K6.2/unit

- Labour & O/h’s = K2850/850units = K3.3529/unit
3rd – Apportioned between finished output and closing WIP
Materials Labour and Overheads
Equiv. Cost per Cost Equiv. Cost per Cost Total
Units Equiv Units Equiv Cost
Units Units
Item K K K K K
Finished 800 6.20 4960 800 3.3529 2682 7642
Output
Closing 200 6.20 1240 50 3.3529 168 1408
WIP
1000 6200 850 2850 9050

Process Account (WIP Account)

Units K Units K
Materials 1000 6200 Finished goods 800 7642
Labour overhead 2850 Closing WIP 200 1408
1000 9050 1000 9050

Joint products and By-products costing

Joint products are two or more products which are output from the same processing operation,
but which are indistinguishable from each other up to their point of separation. For example, in
the oil refining industry where diesel fuel, petrol, paraffin and lubricants are all produced from
the same process.
A by-product is a supplementary or secondary product (arising as the result of a process) whose
value is small relative to that of the principal product. For example, by-products include sawdust,
small offcuts and bark.
The point at which joint products and by-products become separately identifiable is known as the
split-off point or separation point. Costs incurred up to this point are called common costs or
joint costs.
The main methods of apportioning joint costs, each of which can produce significantly different
results are
 Physical measurement
 Relative sales value apportionment method; sales value at split-off point

With physical measurement, the common cost is apportioned to the joint products on the basis of
the proportion that the output of each product bears by weight or volume to the total output. An
example of this would be the case where two products, product 1 and product 2, incur common
costs to the point of separation of K300,000, the output of each product is 600 tons and 1,200
tons and where the sales price per unit is K400 for product 1 and K200 for product 2
respectively..
Product A = ( 600/1800) x K300,000 = K100,000
Product B = ( 1,200/1800) x K300,000 = K200,000

Profit A = K240,000 – K100,000 = K140,000

Profit B = K240,000 – K200,000 = K40,000

With relative sales value apportionment of common costs, the cost is allocated according to the
product's ability to produce income. This method is most widely used because the assumption
that some profit margin should be attained for all products under normal marketing conditions is
satisfied. The common cost is apportioned to each product in the proportion that the sales
(market) value of that product bears to the sales value of the total output from the particular
processes concerned.
Product 1 Product 2 Total
Sales K240,000 K240,000 K480,000
Proportion of common cost 240,000 240,000
480,000 480,000

Apportioned cost 150,000 150,000 300,000

Sales 240,000 240,000 480,000
Profit 90,000 90,000 180,000

A by-product has some commercial value and any income generated from it may be treated as
follows.
(a) Income (minus any post-separation further processing or selling costs) from the sale of
the byproduct may be added to sales of the main product, thereby increasing sales
turnover for the period.
(b) The sales of the by-product may be treated as a separate, incidental source of income
against which are set only post-separation costs (if any) of the by-product. The revenue
would be recorded in the income statement as 'other income'.
(c) The sales income of the by-product may be deducted from the cost of production or cost
of sales of the main product.
(d) The net realisable value of the by-product may be deducted from the cost of production
of the main product. The net realisable value is the final saleable value of the by-product
minus any post-separation costs. Any closing inventory valuation of the main product or
joint products would therefore be reduced.